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Avoiding schoolboy errors when saving for your child’s education

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Thursday June 30, 2011 at 9:00am

How many parents out there are tearing their hair out worrying, not whether their son or daughter will make the grade and get into university, but how on earth they are going to fund them if they do?

If you have a child going to University later this year the cost over 3 years might be as much as £52,000. This is based on course fees around £9,000 per annum, accommodation of £5,000 per annum and living costs on top of say another £100 per week. And that assumes they live at home in the holidays. Even with student loans most parents are going to need to help out.

This is a real concern and I am often asked how to save for a child’s higher education.

A common mistake

People immediately think about putting money into an account in the child’s name to give them a start in life, if it is not used for education it may be used for a deposit for a house.

The problem with this is one of control. You want your son or daughter to use the money for their education but as the savings are in their name as soon as they reach the age of 18 they can withdraw the money and use it however they like. Indeed the bank or provider will write to the child explaining all of this.

The pros and cons of Trusts

People think they can avoid this by simply putting the money in trust. Bare Trusts are simple but the problem of the bare trust is its rigidity (i.e. there is no discretion whatsoever over who is entitled to what and when) and for this reason such a trust is generally only used if it offers specific tax advantages.

The most common alternative is a discretionary trust but Trustees of a discretionary trust are liable to income tax at the trustee rate of 50% in respect of income other than dividends and 42.5% in respect of dividends. If the trustees wish to distribute income to beneficiaries of such trusts, they must account for 50% tax before making the distribution. Discretionary trusts can be very useful but there are better ways of saving for University.

Using a Bond wrapper

Rather than hold the investment in the child’s name why not simply avoid the problem all together and hold the investment in your name as the parent? One way of doing this is to use a Bond wrapper. There are Bonds available in which you can hold any investments you want with tax payable only on the growth above inflation and then only at basic rate, regardless of the tax rate of the owner. You will have to take advice on this as not all bonds offer this facility and it is important that any advice fits your personal circumstances.

The bond wrapper route offers a number of advantages.

  1. The child need never know that you have actually saved any money for them. Even if they do the investment is legally yours unlike putting the money in their name.
  2. You control how the money is used and can hold onto it past the age of 18 without the child becoming legally entitled to it.
  3. You have a very low tax rate on the growth of the investment over the years that the investment is held by you.
  4. You can either cash in the investment yourself (with a possible 20% tax charge on the growth if you are a higher rate tax payer) or alternatively transfer it to the child when you wish and they can encash the investment.

So before you start saving just think about the intended use of the money. Then think about how you can be certain the money can only be used for that intended use. Then think about minimising the tax on the growth and avoiding tax on encashment.

Andy Parker
Chartered Financial Advisor

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